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Cost-push Inflation

As iron and steel, steam. Except being sold by exporting. (b) An economy produces final goods and services with a market value of $900 billion in a given year, but only $875 billion worth of goods and services is sold to domestic or foreign buyers. Is this nation’s GAP $900 billion or $875 billion? Explain your answer. (2 marks) (c) Explain why a new truck sold for use by a transport company is a final good, even though it is a fixed investment (capital) used to produce other goods. 2 marks) Should the value of this truck then be added to GAP or should only the goods it transports be included in GAP? (2 marks) Question 3: (I. A) Illustrate and explain with diagrams the difference between demand-pull and cost-push inflation; (2. 5 marks for the diagram and 2. 5 marks for the explanation); (2. 5 marks for 2 demand-pull causes and 2. 5 marks for 2 cost-push causes) Cost-push inflation is an inflation that results from an initial increase in costs. Two reasons why costs might rise: 1 . Component costs: e. G. N increase in the prices of raw materials and components. This might be because of a rise in global commodity prices such as oil, gas copper and agricultural products used in food processing – a good recent example is the surge in the world price of wheat. 2. Rising labor costs – caused by wage increases that exceed improvements in productivity. Wage and salary costs often rise when unemployment is low (creating labor shortages) and when people expect inflation so they bid for higher pay in order o protect their real incomes.

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Demand-pull inflation is an inflation that results from an initial increase in aggregate demand. Two possible causes of demand pull inflation are:- 1 . A depreciation of the exchange rate which makes exports more competitive in Overseas markets leading to an injection of fresh demand into the circular flow and a rise in national and demand for factor resources – there may also be a positive multiplier effect on the level of demand and output arising from the initial boost to export sales. 2. Improved business confidence which prompts firms to raise prices and achieve better profit margins.

Question 7: (a) The consumer price index (I. E. ICP) is the most commonly used measure of and disadvantages of using this measure. (4 marks) (b) Explain why some people ‘lose’ from inflation and why do some people Win’ from inflation? (6 marks) Answer: It measures the change in price of a fixed market basket of goods and services from one period to another. Advantages:- 1. A high annual percentage increase in the ICP reflects a high rate of inflation. 2. The ICP also determines the percentage of annual increase or decrease in income. 3.

The federal government also uses the ICP to adjust Social Security and disability unifies, to determine the income level at which people become eligible for assistance, and to establish tax brackets. 4. The ICP is often used to compare prices for certain goods within a set of years, and to calculate constant currency values for two points in time Disadvantages:- 1 . It changes over time (consumer goods in the sass are not the same as they are in the sass). 2. ICP overstates inflation, because it fails to account for improvements in technology. . Another problem with the ICP is that changes in the quality of goods and services are not well handled. When an item in the fixed basket of goods is used o compute the ICP increases or decreases in quality, the value and desirability of the item changes. (B) Inflation is: a general increase in prices and a corresponding decrease in money’s purchasing power. If inflation is not expected, it can generate “winners” and “losers”. This means that some people become richer as a result of unexpected inflation while others become poorer.

Debtors are people who borrow money while creditors are people who lend money. In general, when inflation is unexpected, debtors “win” and creditors “lose”. This redistribution is due to three effects: Price effects. As the average level of prices increase, some prices increase faster than others, so some people are more affected than others. For example-The increase in gas prices in the summer of 2000 hurt truckers a lot, but barely affected people who live close to work and drive economy cars.

College tuition has risen almost twice as fast as average prices over the past 20 years, which hurts you a lot, but may have little impact on a married couple with no children. Income effects. Prices for goods and services mean incomes for someone else. So as some prices increase faster than others, some incomes increase faster than others. For example-oil companies recorded huge profits in the year 2000. Wealth effects. Inflation redistributes income between borrowers and lenders. For instance, you borrow $100,000 for a 30-year mortgage at 7% interest, giving you a monthly house-payment of about $665.


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